NY futures slipped this week, as July dropped 180 points to close at 63.73 cents, while December fell by the same amount to close at 64.70 cents.

Spec long liquidation into trade short covering seems to have steered the marked lower this week. July open interest has been in a steady decline since reaching a peak of 124’861 contracts on May 5, dropping by more than 21’000 lots to just 103’504 contracts as of this morning. Meanwhile, December open interest has moved up from 63’661 to 70’886 contracts during the same time frame, as grower hedging has intensified.

A deteriorating technical picture has prompted a number of spec longs to exit the market. So far this liquidation has been very orderly, since the trade has been able to offload some of its remaining basis long positions at these lower levels, which requires futures shorts to be bought back and therefore mitigates the selling pressure emanating from the spec sector.

US exports sales for the week ending on May 14 were once again quite decent considering that the US doesn’t have that many desirable qualities left for sale. Net new commitments of Upland and Pima cotton amounted to 72’200 running bales for May/July shipment and 36’200 running bales for August onwards. There were still 16 markets on the buyers list, with Turkey’s 26’800 running bales leading the group. Shipments were excellent at 362’000 bales, signaling a sense of urgency by mills to get their hands on supplies. With around 11 weeks left in the marketing year, weekly shipments need to average only around 188’000 running bales to make the USDA estimate, which should be easily achieved.

For the current marketing year total commitments are not at slightly over 11.0 million statistical bales, whereof 8.6 million bales have so far been exported. For the 2015/16-season the tally is currently at 1.25 million statistical bales.

Although the short-term trend is currently down, from a longer-term perspective we are still very much in a trading range. For the past eight months the July contract has traded in a relatively narrow band of just 900 points, between 59 and 68 cents/lb. December has been confined to an even tighter range of just 600 points, trading between 61 and 67 cents since last September. So far the market has encountered strong support and resistance to keep prices confined to this range.

The upside is limited by the record amount of global stocks, which according to the USDA are going to reach a 110-million bales by the end of July. This means that global inventories will have more than doubled from the 50.7 million bales we had at the end of the 2010/11-season. Support comes from the fact that over 72 percent of global stocks are located in China (65.3 million bales) and India (14.3 million bales), where governments exercise control over the market via price support and inventory management.

Prices in China are still about 40% above the world market and despite the fact that China has large inventories it continues to be a net importer, albeit at a much slower pace than in previous seasons. Nevertheless, as we have pointed out in our last report, based on the latest USDA estimate China should still import enough cotton from the rest of the world to absorb next season’s production surplus outside of China. If we further take India out of the equation, where the CCI controls most of the available cotton at this point and is unlikely to dump it on the world market, the remaining inventory around the globe hasn’t really changed much over the last five seasons. Excluding China and India, global stocks have been no lower than 28.3 million bales and no higher than 31.8 million bales since 2010/11. In the current season they are projected at 30.6 million bales and next year they are expected to drop to 30.0 million bales. Since mill use outside of China and India has moved up from 49.1 to an estimated 53.5 million bales in 2015/16, the stocks-to-use ratio has actually been tightening, which is why remaining supplies, especially those of machine-picked high-grade qualities, feel relatively tight.

In other words, there is currently no price pressure in any of the major origins and this situation will likely persist into late 2015/early 2016, when the pipeline starts to fill up again. Eventually the market will break out of this trading range, but whether it is a month from now or a year from now is difficult to say.

The current environment reminds us of the 2004-2007 sideways range, when the market traded mostly between 43 and 56 cents for around three seasons, after which it broke out to new highs during the bull markets of 2008 and 2011. A breakout to the upside seems more difficult to achieve this time around, at least not until this massive global inventory has been substantially reduced. A break to the downside could occur if crops around the globe continued to develop well, especially in the US and India, and if consumption were to not live up to the somewhat optimistic expectations of the latest USDA report, which has global mill use for 2015/16 at 115.3 million bales. This would allow stocks outside of China to rise and could put pressure on prices. However, this scenario won’t unfold until the outcome of the Northern Hemisphere crops is better known, which is in the 4th quarter at the earliest given the late start to the US crop.

So where do we go from here? Current sentiment is slightly negative, both from a fundamental and technical perspective. Expectations for a big US crop of potentially over 15 million bales combined with fewer Chinese and Turkish imports has traders worried, while from a technical point of view the July contract has once again broken below the 50-day and 200-day moving averages as of today’s close. This could spark additional spec long liquidation going into the long holiday weekend. The next stop on the chart it trendline support at 63.00 cents dating back to late January. However, the trade is likely going to buy into weakness from here on down, seizing the opportunity to reduce its still sizeable net short position in New York, which is to a large degree made up of basis-long positions and unfixed on-call sales. We therefore subscribe to a neutral to slightly bearish outlook at this point, but having said that, we are hesitant to short the market in the low 60s.